China's developers weigh floor space and global commodities, writes John Garnaut.
IN Chongqing, the new frontier of Chinese urbanisation, clusters of high-rise buildings sprouting among rice paddies and elevated highways and railways are draped over the countryside, with barely a thought for the mountains they punch through and river canyons they span.
Everywhere, it seems, hills are being decapitated and valleys and canyons filled to make way for what officials say will be 2 million more apartment dwellers in the coming three years alone.
This is the China that McKinsey & Co envisions when it projects that the country could build a new Chicago every year for the next two decades, including more than 1500 new skyscrapers higher than 30 storeys.
By 2025, it says in a new report, China is on track to have 219 cities of more than a million people and 24 cities larger than Sydney. In places such as Chongqing, in south-western China, the odyssey from peasant to city resident that comes with entering the international marketplace is only half-way complete.
Every apartment block above about five storeys needs to be reinforced by steel. So, too, every rail tunnel and road bridge and the rolling stuck and vehicles that speed along them. Each tonne of steel requires about 1.6 tonnes of iron ore and 850 kilograms of high-quality "coking" coal - commodities Australia has in quantities that most of the world can only dream of.
This is the seemingly inexorable urbanisation that BHP Billiton's Marius Kloppers, Rio Tinto's Tom Albanese and Fortescue's Andrew Forrest have in mind when they push on with breathtaking new expansions of their Pilbara iron ore mines. Last month, China imported 62 million tonnes of iron ore, 24 million tonnes of which were shipped directly from Australia.
Last year Australia's iron ore exports were worth $49 billion - an astonishing 5 per cent of gross domestic product - and most of that was pure profit because Australian miners can dig and ship it to China more cheaply than anyone else. That figure was up nearly two-thirds from the previous year. And this year it seems likely to jump again, with spot market prices already one-third higher than the prevailing contract prices.
This is the core of a once-in-a century "terms of trade" shift that has boosted Australia's national income by 20 per cent in just over a decade, before factoring in that we are working harder and smarter.
It is what the Reserve Bank will remain focused on as it sets interest rates in coming months, despite this week's weaker-than-expected inflation data.
Everybody, it seems, is keeping faith in the irresistible forces that are bringing 1 per cent of China's 1.3 billion people into the cities every year, as they search and work for a better life. What are new, however, are the rumbling doubts about whether China's policymakers are keeping up with their people.
Inflation was 4.6 per cent in December and is expected to reach 6 per cent in coming months, with food price indices up 8 per cent in January alone. The laws of economics are defying the Communist Party's predilection for central price controls.
The real estate market continues to glow red hot. The number of transactions has doubled since the lows of October, after the government had introduced a second round of tough measures against speculation. On Wednesday night the State Council introduced a third, tougher round of measures to control the market.
Shares in China's listed property companies promptly fell between 3 and 5 per cent, but few in the industry seem to believe the government's central planners will succeed where they have failed before.
"I think the property market will keep booming for years," said Ni Yawei, a senior manager at the Yinxin Group, one of Chongqing's largest property development companies, in his office atop a 30-storey tower his company built. His profit margins are running at more than 30 per cent, he believes the government will never stop the banks from shovelling money his way, and he is snapping up any land he can get in Chongqing and neighbouring Sichuan.
Ni cites the "tremendous demand" for housing caused by migration to urban centres as well as a prevailing mindset that "if I'm going to get anywhere in this place I have to first buy a house".
He says: "People can either put their money in the bank, and get interest rates that are less than inflation, or they can put it in property and a 'two-directional' return from capital appreciation and rent."
Not everyone is convinced that tightening credit policies, while leaving interest rates stuck well below the inflation rate, means that China's property industry is a one-way bet. Increasingly, global investors, policymakers and China watchers are experiencing a creeping sense of crisis. This week - a week in which China's interbank lending rates inexplicably shot up - 44 per cent of 1000 investors surveyed by Bloomberg said China would face a financial crisis in the next five years.
China's leaders for 35 years have demonstrated a much-admired capacity to focus on long-term goals, to manage macro-economic cycles and to steer the once-socialist economy through gradual reform. But faith in the sagacity of Chinese leaders is fading.
"We should definitely be factoring in the possibility that the Chinese economy will go off the rails in the next year or two," says Barry Naughton, whose book on China's economic reforms is compulsory reading at English-speaking universities around the world.
"I see them making so many choices that are not necessarily horrible decisions in the short run but which have long-run costs; and almost no choices that have short-run costs but long-run benefits," says Professor Naughton, of the University of California, San Diego, a specialist in China's economy.
Nobody knows how long the deep structural problems in the Chinese economy can persist before the costs come home to roost. More immediately, investors and policymakers are aghast at the amount of money still sloshing around in the real economy despite nearly a year of efforts to drain liquidity.
On Wednesday, the China Business News reported China's banks wrote 1200 billion yuan in new loans in the early weeks of this month - or about one-sixth of the annual lending target. And many consider that target is too high anyway.
''People worry about a hard landing and my expectation is that it will hardly land,'' says Wang Tao, a China economist at UBS.
But what goes up will come down, eventually. "Timing the bust is always difficult," he says. "Whether it is next year or the year after, I don't know. The later the policymakers take action, the bigger the risks."
The well-regarded Chinese regulators who are charged with managing inflation and asset bubbles are nervous.
Li Daokui, an academic member of the central bank's monetary policy committee, told reporters in Davos this week that inflation would be brought to heel this year but real estate prices remained the "biggest danger".
Liu Mingkang, the chairman of the China Banking Regulatory Commission, said he was ''very concerned'' about inflation and deemed it a ''worldwide'' phenomenon linked to loose monetary policy in the United States. ''For new emerging markets, we are all facing inflationary pressure partly due to capital inflows.''
Chinese officials all the way up to President Hu Jintao loudly claim that their inflation and asset price problems are made in America. But others in the region are not so sure.
"China's loose monetary policy is imposing inflation on the rest of the world," says Michael Spencer, Deutsche Bank's chief economist for Asia. He says China is exporting inflation by overstimulating its own economy and driving up global prices for commodities, including food. And keeping the Chinese currency undervalued is forcing its export competitors to do the same.
"The rest of Asia feels squeezed because US interest rates are at zero and China won't appreciate. The Fed is doing what's appropriate for the US but China is undervalued."
He says China's talk about reducing reliance on exports is only talk, given the decision to stick with an undervalued currency.
"I assume at the end of the day they're not really interested in rebalancing because it's a painful thing to do. They're hoping against hope that they'll get a couple years' more kick from the US."
Prominent economists lament how China's reform agenda has been stalled and perhaps hijacked by internal political jockeying and vested interests.
"They did a good job getting themselves out of the pickle in '08 and '09 but they drew all the wrong conclusions from that," says Naughton. "They said, 'Ha, we see that strong, decisive, interventionist central government is really what we need to differentiate from those foolish Americans and therefore we should do more of it.'"
Literally millions of officials have been politically empowered and many of them personally enriched by the rivers of money that have come flowing their way since the global financial crisis, and they seem reluctant to hand it back.
The possibility of a shakedown in China is growing, even if it is unlikely to bite the real economy this year.
Huang Yiping, a professor of economics at Peking University, says he remains "cautiously optimistic" that the Chinese economy will not hit a wall. He cites the strength of balance sheets for government, companies and households, and notes that the central bank is well into a tightening cycle, with bank capital reserve ratios at record levels. The risks may shift towards overtightening.
"If they really see high inflation they won't tolerate it, that's for sure," says Huang. "Perhaps we need to worry that the government will tighten too aggressively before midyear, so the [real] economy might tighten faster than many would expect in second half. But a bubble bursting in the near term looks unlikely."
Huang says rising wages inevitably will shift the weight of the economy towards households, where it needs to go, despite government inaction.
Migrant wages rose at a record pace of nearly 20 per cent in each of the past three years, says Cai Fang, of the Chinese Academy of Social Sciences, China's leading expert on the subject.
Rising wages add to inflationary pressures but Song Guoqing, a leading macro-economist at Peking University, believes authorities have things broadly under control. He believes "M2" money supply growth will be lower this year than last, at about 16 per cent, although he remains "a little worried" about inflation.
"If domestic demand and particularly exports are stronger than expected then the quantitative money supply may be too much," he says.
Economists, including those outside China, are worried about the risk of a hard landing in China, brought about by the difficulty in fine-tuning monetary policy while holding the currency down.
Increasing bank reserve requirements to "mop up" the liquidity brought into China by the undervalued yuan is costly, and cannot go on forever.
''You're trying to make water flow uphill, which you can do for a while but at some cost,'' says the World Bank's chief economist in China, Ardo Hansson.
Some analysts are even asking whether a spike in inter-bank lending costs in China means there are liquidity problems.
"As much as people can believe stronger-for-longer and all the rest of it, most indicators we look at for China indicate that the rate of growth is slowing," says Atul Lele, the Australian equities strategist at Credit Suisse. ''It doesn't mean that Australian resource companies are immune but they are yet to react. There is an opportunity there on the short side"
It all depends on your timeframe, because down in the provinces nobody seems to have noticed that regulators have been draining liquidity.''
In Chongqing, a province of 29 million people with an urban centre of about 6 million, the data on annual floor space under construction tells the story. In 2003 developers and migrant labourers built 78 million square metres of residential real estate. This accelerated to 138 million square metres in 2009 and last year's preliminary figures suggest a jump to 180 million.
Stephen Joske, of the Economist Intelligence Unit in Beijing, says the figures suggest Chongqing is due for a "correction".
Local developers and officials are not listening. "I've just come back from a meeting of the Chongqing property developers' association," said Ni on Thursday morning, just after the State Council housing market controls came in.
"Development is excellent because Chongqing prices are not as high as [in] the bigger cities. The city economy is doing well so incomes are rising and Mayor Huang Qifan has managed to reserve huge tracts of land for development."
Ni, like any self-respecting developer in China, is careful to align his interests with those of the officials he depends on, all the way up the tree. His company's advertising material consists almost exclusively of his boss shaking hands with various luminaries, including President Hu, Premier Wen Jiabao and the next likely president, Xi Jinping.
Whatever the central leadership is signalling, Ni believes local officials will keep the property industry humming. "I think the property market will keep booming for years because it's good for the Government," he says. "Real estate is the dragon head that drives industry, design, construction, steel and cement companies along."
Lending is not a problem. Banks need to lend money out and the top 10 property developers will get special treatment.
On Thursday night, Huang called a press conference in which he casually revealed that Chongqing's GDP growth last year was 17.1 per cent. That was in line with two other provinces benefiting from the central government's "Go West" campaign, Qinghai and Inner Mongolia, but well above the national rate of 9.3 per cent.
Huang announced new property taxes on expensive houses and specific measures in line with the State Council's new controls but his message was broadly one of reassurance.
He denied government revenue was dependent on property development and he talked about spending 30 billion yuan in government money and adding 70 billion yuan in bank loans to build public housing for 2 million people over the next three years.
"Don't ever think we are short of money when building public rental housing," said Huang. "The government cares about property market because it's fundamental for people to live in peace and work in joy. But we don't think it's the major impetus of local development.''
Meanwhile, flush with cash, Chinese traders have been hoarding record volumes of iron ore and the country's property engine is set to keep humming for a while yet. The spot price of iron ore was above $US185 a tonne this week, or about one-third higher than the current quarterly iron ore contracts.
Australian miners shifting to monthly contracts, especially BHP Billiton, are already enjoying this huge spike in income. Others, especially Rio Tinto, will feel the tailwind when the next set of quarterly contracts begins in April.
The floods in Queensland have sent the price of coal - Australia's second largest export - through the roof. This new surge of national income will take months to wash through the Australian economy, before the tide inevitably recedes.
And Ni, the Chongqing property developer, is perfectly aware of the correlation between the amount of floor space under construction in China and global commodities demand.
He believes the end is not in sight. "I'm thinking of investing in iron ore mines in Australia," he says. "Actually, I'm already in negotiations."